Pay As You Earn is Not What it Appears

There has been a lot of press recently about expanding the Pay As You Earn (PAYE) plan for paying back your student loans. Generally speaking, Pay as You Earn creates a payment of 10% of your income. And promises debt forgiveness after 20 years.

It’s important to keep your “common sense” hat on when looking at this program and deciding which repayment plan is in your best interest. You pay down debt by paying down the principal balance. The more you pay, the more the debt goes down.

The allure of PAYE is to reduce your monthly payment. The opposite of what it takes to drive your student loan balance down.

Here are some posts that will help you if you are considering one of the student loan repayment plans based on income.

The Pay As You Earn Plan Drives More People Deeper Into Student Debt

And this is part 2 in a series 11 downsides to be aware of.

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How Are You Doing on Your Budget So Far?

A monthly budget is a powerful tool for paying off your student loans.

As Dave Ramsey says, a budget is how you make your money behave! He also says that using a budget will make you feel like you got a raise. It’s true.

Erasing $20,000 in Debt in 2 Years – In New York City!

Here is a quote from a great story about getting serious, and using a budget, to get rid of your student loans.

“Just months after getting our diplomas framed, Joanna and I sat down and got serious about our finances and attacking our $20,000+ in student loan debt. While interest rates were favorable and our cumulative debt was lower than many graduates, we couldn’t stand the feeling of owing anything to anyone. Imagine our conundrum when I got my dream job offer from a storied advertising agency in New York — the most expensive city in America.

Despite a cost of living that’s 125 percent higher than the U.S. average, we were committed to paying off our debt in two years. And the craziest part of it all? We did it. (We were in Manhattan for a year and a half, and then we moved to Boston for a year.)”

Here’s another quote about how they attacked the debt.

“Instead of first budgeting out typical expense categories (food, transportation, tourist activities, etc.), we figured out how much we wanted to put toward paying down our debt each month. After subtracting that from our monthly income, we knew how much money we had remaining for all of our discretionary and leisure spending.

We created an itemized budget and then tracked our expenses like accountants from the Internal Revenue Service. Every penny of every expense was accounted for throughout each month. If we noticed that our $350 food budget was running low halfway through the month, we knew to cut back or face the wrath of beans, rice and ramen for the duration. This tracking helped ensure that our get-out-of-debt goals were walking the walk.”

Here’s the full article about how they did it. Check it out. It’s a fun and motivating story.

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The Pay As You Earn Plan Drives More People Deeper Into Student Debt

The Pay As You Earn (PAYE) student loan repayment plan is driving more people deeper into debt. Its original intent was noble because it can provide a safety net for those with large student loans and who do not graduate or who do not make a lot of money after college.

The bad news is it promotes staying in debt for 20 (10 years in certain cases) years in the hope of some debt forgiveness (which would be taxed as income in many cases). It also makes the monthly payment very low in order to encourage the student to spend money on other stuff. To become a “consumer” and start spending their money.

It also promotes more students going deeper into debt.

The Wall Street Journal wrote an insightful article titled Federal Plans That Forgive Student Debt Skyrocket. Here is a quote from the article at yahoo finance:

“Law schools at Columbia University, the University of Chicago and Georgetown University are among those offering some graduates additional aid to cover all or part of their minimum monthly payments under the federal plans.

Max Norris, a 29-year-old lawyer for the state of California, illustrates the potential costs of the program. He pays about $420 a month to the Education Department on his $172,000 in debt, which he says fails even to cover the interest owed. But his out-of-pocket expense falls to $100 monthly after aid from his school, University of California’s Hastings College of Law.

Mr. Norris, who makes $60,000 a year in his job, would have about $225,000 in debt forgiven after 10 years, assuming he stays in public service and his salary rises 4% annually, according to a repayment calculator created by the New America Foundation, which advocates less-generous forgiveness.

He said he learned of the programs before enrolling. “My intent the whole time in going through law school was to take advantage of this program,” he said.

Schools aren’t shy in touting the programs’ benefits.

Georgetown said on its law-school website until recently the school’s aid combined with the federal plan “means public interest borrowers might not pay a single penny on their loans—ever!”

I wrote a number of posts about the downsides of PAYE to try to prove to you that it was something to stay away from unless you were nearing default on your student loans.

Read this real quick. It summarizes 11 downsides to be aware of.

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Interest on Student Loans is Your Enemy

You probably have lots of friends in your life. But I promise you, interest on your student loans is not one of them.

Interest on student loans is your enemy. And the only way you can kill the little bastard is by making sure that your monthly payment is big enough to pay the interest for the month plus as big a chunk of the principal as humanly possible.

Tuition.io wrote a great post that will help you learn more about how interest on your student loans really works. You’ll do yourself a big favor to read it now.

Interest on student loans works different than what you may be accustomed to on credit cards or cars.

VERY different.

Especially if you are on one of the programs that provides you a “low monthly payment”.

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A Fun Story of a Couple Who Got Serious About Paying Off Their Student Loans

Here’s a fun story about a couple who got serious about paying their student loans off quickly. It’s a great example of being intentional about getting out of debt.

Here is the essence of how this couple decided to tackle their student loans.

“Rather than starting off our adult lives buying new vehicles, taking vacations, purchasing new electronics and appliances, or buying a home, we denied ourselves these enticements. Rather, we rented a small 600 square foot apartment, worked overtime, made most of our meals at home, didn’t take vacations, and drove used cars.

In turn, we were able to keep costs to about a 30 percent of our combined income. This allowed much more money to go toward student loans.

And by paying as much as we could toward loans rather than just the standard monthly payment, we had my wife’s loans paid off in less than three years…and so, the wedding planning began.”

It took sacrifice and a commitment to make it happen. That’s the important takeaway.

I doubt it was necessary to hold off the wedding until they got rid of the student loans! But maybe that helped.

If nothing else, it made the story a little more controversial… and probably increased the number of people who read it.

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Changing Your Family Tree

I love to hear stories of people dealing with student loans and deciding to pay them off quickly. And I really love it when they go so far as to start saving for their own children’s college… even grandchildren’s college.

Roger wrote this on a LinkedIn article I published about student loans and how they are marketed as something every student has to have:

“I absolutely have a problem with it! As a student, I was fortunate to have both scholarships and a part-time job to help. I graduated, married, with #2 child on the way and three job offers to begin my career, AND NO DEBT. However, all of my five children incurred some debt to complete their college and I incurred too much debt to help them have less. Ouch! Living under the debtor is SLAVE to the lender truth, our family waged the war to get out of that debt.

I now encourage my children to save for college for my grandchildren and I am now saving some for the grandchildren to hopefully change our family tree to have our grandchildren graduate debt free. Any method that makes it EASIER to borrow and EASIER to not get paid back quickly is a disservice to the next generation.

As a taxpayer, YUCK, I want the government out of my life and my children and grandchildren’s life. I DON’T want them depending on government for anything, especially being in DEBT to them. The erroneous belief that someone else should pay for it, IE forgive the debt after 20 years, is no way to build up financial independence of our Professionals and Entrepreneurs of the future!”

You’ve got to love his spirit and determination.

Here’s my response to Roger’s comment:

“I agree Roger. You made the case perfectly. Nobody considers the implications of the government encouraging all this debt, and under the new Pay As You Earn plan, encouraging super low monthly payments and staying in debt for 20+ years. Staying in debt and teaching young people to spend more of their income kills their ability to save for their own children.

The government is teaching young people the opposite of financial intelligence. They are teaching financial illiteracy. They are teaching government dependence in the name of education.

It’s already hard enough to save money. Encouraging a person to stay in debt for 20+ years makes it next to impossible. This is one of the best reasons to go “gazelle intense” as Dave Ramsey says and sacrifice after school so a person gets the loans out of their life.

“Education” and the word “debt” don’t really go together. If a person does mix them, they are wise to get rid of the debt quickly. That way their educations can be used to build a better life for themselves and their family. That way they can become strong financially.

I have a huge amount of respect for the approach you are taking Roger. You rock!”

Great story that I hope you will consider making a part of how you deal with, and payoff, your student loans. Family trees are changed one person at a time.

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An Opportunity to Help a Young Person Prepare Themselves Financially

If you are a parent, a soon-to-be-parent, or a grandparent, I encourage you to take a couple minutes to peek into the mind of a young person.

Here is a very interesting article by a high school senior about what she is being taught about debt and going to college. It is both telling and scary at the same time.

But more than anything it is an example of how you can teach your kids a wise approach to money, debt and getting a good education.

She ends the article in a dramatic fashion. Maybe by design… maybe because she really thinks it is true.

Read it here.

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Are You Investing with Borrowed Money?

One of the questions that usually comes up when talking about how fast to pay off student loans is “Well, shouldn’t I invest my money rather than pay extra on my debt? It will grow at a rate in excess of the interest I am paying on my loans”.

The wise answer to the question is NO. You should pay the debt off as fast as possible THEN start saving and investing. Getting out of debt is remarkably freeing. It creates financial strength. It demonstrates you have the discipline to make decisions in life that fit within your financial means.

Here is an article titled Should You Borrow Student Loan Money to Invest. Read it and see if you generally agree with his answer.

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Ken Paid a Price to Become Free From His Student Loans

I love reading stories about people who paid a price to become free from their student loans. Ken Ilgunas is a guy who went to great lengths to pay his student loans off quickly. I love it.

Here is a quote from the beginning of the article:

“By the time Ken Ilgunas was wrapping up his last year of undergraduate studies at the University of Buffalo in 2005, he had no idea what kind of debt hole he’d dug himself into.

He had majored in the least marketable fields of study possible — English and History — and had zero job prospects after getting turned down for no fewer than 25 paid internships.

“That was a wake-up call,” he told Business Insider. “I had this huge $32,000 student debt and at the time I was pushing carts at Home Depot, making $8 an hour. I was just getting kind of frantic.”

Wait until you see what he did next!

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Take a Look at the Big Picture

This post is for you if you own or manage a business (or plan to some day).

Over the years, I have learned that it’s wise a couple times each year to step back from your day-to-day role in your business and look at things in a more big-picture, strategic kind of way.

I wrote an article for the Business Bank of Texas recently where I set out 8 great ideas for you to consider as you take that bigger picture look at your business. Here are the 8 topics.

  1. Stop doing things that lose money.
  2. Learn what’s really going on with your cash flow each month.
  3. Pick an important business process to simplify.
  4. Create monthly cash flow projections for the next six months.
  5. Use your monthly financial reporting process in a more strategic way.
  6. Decide that accurate monthly financial statements are better than inaccurate ones.
  7. Create a written capital expenditures plan.
  8. Put yourself in the shoes of an investor or lender.

I know it’s difficult to think strategically and big-picture when you are down in the weeds of your day-to-day work. But it provides you a golden opportunity to rise above the daily challenges and open the door to some exciting new improvements that only need one thing to become reality… your decision to make it happen.

I go into more detail on each of the 8 topics here.

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